One of the things missing from these articles, however, is an attempt to examine the question quantitatively. Is there, in fact, a boom, and if so, what does it look like? Ever since running across the Kauffman Foundation’s report “Starting Smaller; Staying Smaller: America’s Slow Leak in Job Creation” via Andrew McAfee and Erik Brynjolfsson’s “Race Against the Machine,” I’ve been curious about how the technology industry’s job creation compared to the rate overall. Working backwards from the same source of data that the Kauffman Foundation used – the US Census – it was simple enough to collect basic job creation data for the US. What was missing was insight into technology company starts. Fortunately, AppFog’s Chris Tacy had sourced relevant data from the National Venture Capital Association and the UNH Center for Venture Research. Plotting overall industry business creation as measured by the census against the volume of seed and venture deals, normalizing the data in the process, this is what we find (Census data is only available for 2009 and earlier).

The trendlines are more gradual than “startup boom” rhetoric might lead one to believe, but they do support the assertion that business creation in the technology sector exceeds that of the wider job market. There are two notable spikes in venture activity; the first, from 2002-2004, roughly coincides with the dot com boom. The second, beginning in 2006, is likely attributable to something else entirely.

Over on the AppFog blog, Tacy notes an odd phenomenon: while the normalized volume and deal size metrics initially track closely, beginning in early 2006 they are effectively decoupled as the volume of deals spikes while the average deal size falls dramatically. A replication of his dataset is below. The question is what caused this phenomenon.

Tacy attributes this to the rise of Amazon Web Services and the subsequent rise of the cloud market. And it’s difficult to argue that S3, launched March 2006, and EC2, launched in August of the same year – not to mention the market they helped to create – haven’t had a profound impact on the costs associated with business formation, and thus, the attendant risk. As Flip Kromer put it: “EC2 means anyone with a $10 bill can rent a 10-machine cluster with 1TB of distributed storage for 8 hours.” The cost model is inarguably more disruptive than the underlying technologies that power the cloud.

It is also likely, however, that the rise of seed-stage startup funding companies like Y Combinator (founded March 2005) were a catalyst in the above equation. It’s difficult to envision the comparatively small funding levels having had the same impact in the absence of cloud platforms that minimize upfront capital expenses. But with 316 companies funded from 2005 through 2011, Y Combinator would account for approximately 13% of the total venture deals in that span according to the data above. Factor in the funding firms such as Tech Stars that have followed, and the impact of Y Combinator is undeniable.

However the trends are accounted for, the takeaways are clear. Business creation in the technology sector is outperforming the wider market, while the capital required for formation – and thus the risk attached – is in clear decline. Both of which bode well for an economy desperate for an increase in employment opportunities.

3 Responses

It has always been cheaper in terms of capital per employee to start an IT business than any other kind of business so this kind of business “outstarting” business overall when capital is scarce is no surprise. The other influence is that the pricing model for infrastructure has changed from one-time to usage-based (skipping recurring fixed).

I also suspect that there’s a dynamic whereby cloud delivery and mobile creates a lot of business opportunity for software that doesn’t necessarily take a lot of capital to develop & deploy. And, in fact, probably tends to reward investors who make a lot of modest bets rather than a few big ones. I also wonder whether your stats actually understate the tech trend in that there are presumably also lots of new startups that don’t require VC funding at all.